Orr: Detroit Will Emerge From Ch. 9 With Market Access

The process of the bankruptcy and the mediation has certainly helped us, said Detroit Emergency Manager Kevyn Orr.

CHICAGO -- As Detroit reaches key settlements with its pensioners that hinge on minor benefit cuts or none at all, some are asking whether the long-struggling city needed to file for bankruptcy in the first place.

It's a question that's impossible to answer, according to Detroit Emergency Manager Kevyn Orr, the man who took the Motor City into the largest municipal bankruptcy in U.S. history.

"I understand the temptation of some folks to look at the outcomes and say, 'Hey, that ain't so bad,'" Orr said in a wide-ranging interview with The Bond Buyer April 15, hours after the city announced fresh settlements with its retirees. "That's a chicken and egg question. The process of the bankruptcy and the mediation has certainly helped us," he said. "I'm a bankruptcy practitioner, so I just view it as another tool. I don't have the visceral response that others have."

Orr noted that $816 million in state and private funding that has been negotiated to help fund pensions was not on the table until the city declared Chapter 9.

"We tried to get there without bankruptcy and our parties were not interested in doing that," he said, referring to several lawsuits filed last summer in the weeks ahead of the filing.

Detroit's bankruptcy process has sped up over the last few days. The city last week reached a deal with the three bond insurers who wrap its unlimited-tax general obligation bonds, and won crucial court approval for an $85 million interest-rate swaps approval. It also closed on a $120 million loan with Barclays that took months to nail down.

On Tuesday, the city announced a deal with its police and fire pensioners that called for no pension cuts and, late in the day, the city's two pension funds announced they had agreed to a tentative arrangement that called for 4.5% cuts for general employees.

In addition to defending the bankruptcy, Orr discussed the motive behind his sudden decision to treat the city's ULTGOs as secured, and the total illegality, in his view, of the $1.4 billion of pension certificates that remain unsettled. He also talked about how the city plans to maintain crucial access to the debt markets in the future despite its high-profile default on all debt payments starting last year.

In a Bond Buyer interview last June, Orr warned bondholders of major haircuts and said they should have known better than to buy GO bonds in a distressed city without some kind of credit enhancement or statutory lien. He understood the "whole moral argument" of the full faith and credit pledge, he said at the time, but "unsecured claimants always say, 'It's not me'."

On Tuesday, Orr was more conciliatory toward investors, noting that they had helped finance key infrastructure and quality of life improvements for Detroiters.

"These are people who lent money to the city for parks and recreation and infrastructure," he said. "The ULTGOs are standard municipal financing. We're not trying to tear up municipal finance doctrines as we know it."

The settlement calls for the ULTGO insurers to recover 74% and be treated as secured due to a voter-approved property tax millage dedicated to debt-service payments. The insurers will pay bondholders in full.

Driving the city's settlement was the risk that it would lose access to the property tax millage, Orr said.

Ahead of the deal, the insurers had sued the city, arguing that it was illegal for Detroit to use the millage for any other purpose than debt service payments. The city will now get access to the rest of the millage revenue that doesn't go to the ULTGO holders.

"We get access now to 26% of the millage that we otherwise would not have access to," said Orr. "It's the only alternative way, otherwise we would have to do away with the millage or not let the city participate. Part of the settlement also came from [the insurers'] understanding of the risk that it could go away for them as well."

Orr explained his changed position on the secured status of the GOs as due partly to the "very fluid, very dynamic art of negotiation."

The ULTGO settlement also gives the bond holders a lien on local state aid - a fourth lien -- to help secure the status of the debt should Detroit's problems return.

Orr downplayed the new pledge, saying he didn't think it would be necessary for future GO deals to feature a similar lien.

"That's a pretty remote lien," he said. "I don't think the future GOs will have any liens like that. The reality is, in personal bankruptcy, when someone emerges, the next day they're the same person, just a different risk."

The now-secured ULTGO 74% recovery rate is higher than the city's recent offer of 15%, but it's still lower than the proposed recovery rates of unsecured pensioners, who are seeing no or 4.5% cuts.

When asked about the disparity, Orr said the creditor classes are simply too different to compare.

"When you're looking at different classes of creditors, you have to be careful not to compare apples to oranges to pears, because each class is different," he said.

The higher recoveries for pensions and pensioners come in part from the improved performance of the two pension funds over the last six months, he added. That's due more to increased supervision and managerial oversight of the boards than pure market returns.

While Orr calls ULTGOs a standard municipal financing tool, he still takes a different view of the $1.4 billion of pension certificates of participation issued in 2005 to fund Detroit's two pension funds.

In February, the city sued to invalidate the debt, saying it was illegally entered into by a pair of sham entities called service corporations. He said the deal was so shady that one Michigan law firm would not take it on.

"The COPs had such serious questions that one of the city's law firms refused to do the transaction because they thought it was inappropriate," Orr said.

He wouldn't talk much about the lawsuit, saying it was in litigation. But he did say that the city's Jones Day attorneys had considered the risk that the lawsuit, if successful, could end up forcing the pension funds to disgorge the proceeds.

"It's something we analyzed in bringing the claims we brought," he said. "I think we've adequately addressed the risk in our filings."

Detroit's ability to access the debt markets in the future will be crucial to long-term success, said the manager, and he's confident the bankruptcy process is helping to create that future access.

"Any city needs access to capital to grow and thrive. We've heard the concerns about access to capital, but the reality is that money is green," Orr said. "We're operating on the assumption that if we do this right, and get the city's fiscal position straight, then people who do orthodox and appropriate underwriting will get a credit-worthy obligor."

The city expects to do a $300 million financing when it exits bankruptcy that will pay off the $120 million Barclays loan and cover the $85 million swaps payment. Orr said it will likely be a public offering and that he expects several banks to bid on the financing.

"We think reasonable people in the capital markets will lend to a debtor that has gotten their financial house in order," he said.

Detroit officials have crafted a $1.5 billion plan for the next 10 year period. The proposal's revenue projections are cautious and it includes no detailed plans for new revenues.

Orr said the $150 million in expected annual investments will be crucial to creating new revenue, and the projections are cautious enough to be sustainable.

"We get $150 million a year for 10 years, and those are core city services that are drivers for revenue enhancement," said Orr. "But we want to be realistic. The proposals will take some time to turn around the direction of the city ... We have lots of detail in the plan that we've provided, it's just that some of the folks in the public sector don't understand how focused and detailed our plan is."

Despite the handful of settlements reached during the last few days, the case is far from over, Orr said.

The deals are still tentative and could still collapse. The limited-tax GO holders and water and sewer bondholders, who hold $5.9 billion of debt, have not yet reached deals. A critical deal to privatize the city's massive water and sewer department remains stalled. And litigation is still outstanding with the holders of the $1.4 billion of COPs, and Syncora and Financial Guaranty Insurance Co.

With the recent settlements in hand, Orr said he's feeling "very pleased" but cautious.

"We're just trying to do the right thing in the right way and we're hopeful that all parties will recognize that this will be just a snapshot in a history of a great city," he said. "We've had a pretty good run the past couple of weeks. But I'm always expecting a rogue wave to come across the transom."

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